Credit rating agency Moody’s Investor Service has downgraded the credit rating for the city of Chicago, Illinois to junk, reducing the rating of its $8.1 billion of general obligation by two to Ba1, along with a negative outlook. That’s right under investment grade.
The reduction lets banks demand that the Illinois city pay back the debt it owes them early. It also makes Chicago vulnerable to fees to terminate swap contracts.
Aside from the Michigan city of Detroit, Chicago is the lowest-rated of any large city in the U.S. Moody’s downgrade comes after the Illinois Supreme Court decision over retirement benefits last week. The court unanimously decided that a state pension law to reduce government worker benefits, which would get rid of $105 billion in retirement system debt, was unconstitutional. Now, there is skepticism over whether Chicago can keep its $20 billion pension fund short fall under control.
The city’s retirement funds are in financial trouble because for years money was not put aside to take care of the promised benefits. Chicago has four pension funds with collectively over $20 billion in unfunded liabilities. The city claims it currently has only about half of the assets needed to pay for retirement benefits. In 2016, the yearly payment into worker pensions is expected to go up by $600 million.
The state law, which went into effect in 2013, stopped automatic, compounded annual cost-of-living increases for people that were retired while extending the retirement ages for state workers that are still on the job. It also restricted how much of a worker’s salary could be used to figure out pension benefits.
Workers’ unions sued, contending that according to the Illinois constitution, pension benefits are a contractual agreement, which cannot be “diminished or impaired” once they’ve been granted. A circuit court judge agreed with the plaintiffs, but the state government appealed on the grounds that economic necessity compelled its actions.
The Illinois State Supreme Court justices, however, disagreed, finding that the law violated the state constitution’s pension protection clause. The court said that state worker retirement benefits that are promised on the first day of employment could only be increased, not reduced. Meantime, lawsuits submitted by some 60,000 employees—the complaints had been on hold pending the outcome of this case—will have to be dealt with. The ruling impacts not just the state government but also taxpayers of Illinois municipalities that are trying to deal with increasing pension debts.
Standard & Poor’s, Fitch Ratings, and Kroll Bond Rating still have Chicago rated as investment-grade.
Chicago Faces $2.2 Billion Bank Payout After Rating Cut to Junk, Bloomberg, May 12, 2015
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